Europe’s largest banks are to prove their capital will not fall below 5.5% of their assets during an economic crisis, the European Banking Authority (EBA) – the Europe’s primary banking regulator – has said.
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This includes Britain’s four biggest banks – Barclays, HSBC and bailed-out Lloyds Banking Group and Royal Bank of Scotland – who will be among the 124 banks being tested across the EU.
The stress tests are an attempt to end lingering doubts over banking system after the fiscal crisis.
They will also “assess the potential for systemic risk to increase in situations of stress,” the EBA said, with the evaluation being “based on consistency and comparability of the outcomes across banks.”
The evaluation will be revealed in October.
Whilst the precise terms of the tests have not been announced, other major global players – including BNP Paribas, Deutsche Bank and Santander – will face measures involving credit, market and sovereign risk, securitisation and funding costs.
The tests are covering the three years leading to 2016, and will measure a bank’s ability to maintain a measure of capital above 8%, and above 5.5% during stressful scenarios.
In an extra measure intended to add further reliability to the tests, the banks are required to complete an internal asset quality review to measure how their loans are assessed and valued.
As the third series of tests imposed across the EU since the 2008 fiscal crisis, the threshold has been increased from its previous 5% target.
Local regulators are also being given the power to “set higher hurdle rates and formally commit to take specific actions on the basis of those higher requirements.”
No details have been given to consequences or actions which would need to be taken in case of failure, nor how long a bank would be given to correct any capital shortfalls.
The tests have had an ignominious history, facing a near-constant stream of criticism for being too lenient and consequently allowing staggering cases to escape notice.
This includes the clean bill of health awarded to Ireland’s banks, and their subsequent bailout, and the Franco-Belgian Dexia case, which passed the EBA’s stress tests in July 2011 – only to be bailed out twice three and 15 months later.
Yet the hope remains the third wave will allay fears in a post-crisis Europe and, ultimately, be a more precise predictor of banking default.
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